SBI merger: Temporary pain worth its while

Analysts expect return ratios consolidated entity to improve by 300-400 basis points

While the merger ratio of State Bank of India (SBI) with its associate banks has been taken well by the market, some analysts question the timing of this merger.

A recent report by Religare Capital Market warns of further deterioration in the asset quality of SBI after the merger given the questionable asset quality of some of the associate banks. Likewise, a report by Deutsche Bank highlights a steep escalation in cost of operations in the near term. But, every merger comes with a cost and taking cognizance of complexities involved in integration of workforce, bank operations/network and loan accounts, Ajay Bodke, CEO and chief portfolio manager at Prabhudas Lilladher, advises investors not to judge the merits of merger based on the transient pain. “Given that the merger would result in creation of a bank which would be about five times bigger than its immediate private-sector peer, the cost associated with the merger is reasonable,” he says.

One of the immediate merger-related concerns in the banking space is integration of the technology platform. Thankfully, as SBI and its associates operate on the same technology and systems, it means one less integration issue for the bank. As for the workforce, a report by Antique Stock Broking highlights that the combined employee base of SBI and its associate banks, which now stands at 280,000, is expected to decline to 240,000 to 250,000 over the next two to three years, aided by continued retirement and attrition rate. This might not be difficult to achieve, as SBI has already been successful in bringing down its standalone employee count in the recent years. Likewise, SBI also plans to shut or convert some of its existing branches into automatic teller machines to rationalise its network presence. While these would involve significant costs given that SBI is already bracing for Rs 3,000 crore of outflow on account of provident fund liabilities, on a longer-term basis, costs will marginalise.

Antique Stock Broking estimates a cost saving of Rs 1,500 crore in the year following the merger. This is when the merger benefits will start accruing. Consequently, the consolidated entity might see its cost-to-income ratio fall 150 basis points from the current 49.5 per cent of SBI.

This improvement in costs should reflect positively on stock valuations. According to calculations of analysts at Motilal Oswal Securities, higher revenue inflows and cost saving would lift its key valuation metric – return on equity from 6.8 per cent in FY17 to 10.3 per cent in FY18, when the benefits of merger accrue.  Given the long-term advantages, six of eight analysts polled on Bloomberg after announcement of swap ratio retain their ‘buy’ recommendation on SBI’s stock with an average target price of Rs 278.